Topic 3 - The Uk Macroeconomy Flashcards
What is economic growth ?
Economic growth is defined as an increase in real GDP. That is an increase in the real value of goods and services produced in an economy in a given period of time.
How often is economic growth calculated?
It is usually calculated on an annual or quarterly basis and is given as a growth rate.
If real GDP is growing what does this mean for the value of goods and services ?
the value of goods and services being produced is rising. So it should mean, ceteris paribus (everything else equal), that incomes and standards of living are rising
What’s a better measure of economic strength than GDP ?
real GDP per capita (per capita means divided by the population).
E.g. China’s real GDP is X, but its GDP per capita is Y because it has so many people. Whereas Qatar’s real GDP is X but its GDP per capita is higher. So the “average” person has a higher income in Qatar than in China.
What’s an additional exchange rate adjustment that equalises the price of internationally traded goods across countries
Purchasing power parity (PPP)
What’s is this ?
If, at a certain exchange rate, it is cheaper to buy goods in one country than another, businesses will buy goods in the cheaper country and sell in the other for a profit.
This is arbitrage. It forces prices and exchange rates to align over time, e.g. increased demand in the cheaper country might lead the price there to eventually increase, closing the ‘gap’.
What are the benefits of (purchasing power parities) PPP?
The PPP exchange rate remains fairly constant year round, so it can be easily compared.
Exchange rates will often get closer to the PPP as time passes.
Knowing the PPP will allow you to track and predict exchange rate relationships.
PPP can help you to examine the relative living conditions of different countries.
What is the term that describes being able to buy goods in cheaper countries and sell them in other countries for profit?
Arbitarge
National income is used to assess what ?
changes in living standards in a country, and between countries, over time
What is national income defined as ?
the total value of goods and services produced in an economy in a given period of time
What is national income the same as ?
national output, or GDP
What is higher GDP correlated with ?
higher incomes and so a higher standard of living
What can we use national income over time to see ?
whether people are generally getting richer over time or not.
What are the issues with national income being used to compare standards of living ?
Two countries could have the same level of GDP (national income), but the country with a larger population will have a lower ‘average’ GDP per person. So we can improve national income data by looking at GDP per capita (GDP divided by population).
What is nominal GDP ?
GDP at current prices – it means the GDP data has not been adjusted for inflation
What is real GDP ?
Real GDP is inflation adjusted. Adjusting for ‘Purchasing Power Parity’ may help to solve this issue
Two countries could have the same level of GDP (national income), but their cost of living could be higher in one country.
So, the same income purchases fewer goods and services, and quality of life will be poorer.
What should be used to compare these ?
Rather than using current GDP, we should use real GDP.
In some countries, especially developing countries, why is the quality of GDP weak ?
They have poor data collection agencies
What is the shadow economy ?
illegal activities that create GDP but are not recorded in the formal economy.
E.g. the sale of illegal drugs or undeclared ‘cash-in-hand’ transactions.
Two countries could have same reported real GDP, why might one of the countries have an actual income that’s higher ?
Some countries add an estimate for the shadow economy
but one may have a larger shadow economy, so the others actual income is higher.
Explain real variation and inequality
National income is an aggregate of the countries entire output. But often there is variation.
E.g. in the UK, over 25% of GDP is created in London.
Two countries could have the same GDP but the income and wealth could be distributed differently.
E.g. Qatar has a high GDP per capita, but it is not distributed very equally.
What is sustainability defined as ?
defined as “the ability to meet the needs and wants of the current generation, without compromising the ability of future generations to meet their needs and wants”.
GDP measures the total value of goods and services produced but what does it not take into account ?
GDP measures the total value of goods and services produced but it doesn’t take into account the cost of making that output.
A country could have a high GDP but it could be using up all of its raw materials, minerals in doing so. So it is unsustainable.
Why is national income not always a good measure of economic growth ?
Doesn’t take into account:
Sustainability
Composition of GDP
National happiness
Working hours and leisure time
Externalities
What is inflation ?
Inflation is defined as a persistent increase in the general price level over a given period of time
How often are inflation figures given ?
Inflation figures are normally given on an annualised basis
What are the most common measures of inflation ?
CPI (Consumer Price Index)
RPI (Retail Prices Index)
How is inflation measured ?
They are calculated by measuring the change in the value of a basket of goods and services.
How is the rate of inflation each year found ?
In the UK, the Office for National Statistics (ONS) calculates the inflation rate by collecting prices on a basket of around 700 representative goods and services.
Each item is weighted in the basket according to the % of household income spent on them. So higher weights means if the price of that item changes, it has a larger impact on the overall value of the CPI and inflation.
The basket (items in it and the weights) is updated once a year to reflect changing consumer consumption behaviour.
How I’d inflation an economic indicator ?
One reason inflation is an indicator of the strength of the economy is because high and unexpected inflation would mean goods and services are becoming unaffordable as the purchasing power of income falls.
How do you calculate an index number ?
You need to choose a “base”. This is commonly a year but doesn’t have to be.
It is the “thing” that everything else is being compared to.
E.g. if the base year is 2008, then the index number in 2009 is being compared to 2008, the chosen base year.
It is convention to set the base year index number equal to 100.
To calculate an inflation rate we use the following formula: (New value / Base year value ) x 100.
If the price level increases from an index of 120 to 132, what does this indicate?
Increase in price of 10%
What’s deflation ?
Deflation is defined as a persistent decrease in the general price level, over a given period of time.
Prices are going down.
What is disinflation ?
Disinflation is a decrease in the rate of increases of prices – it is when inflation falls but remains positive.
If the inflation rate falls from 5% to 2%, prices are still rising, just at a slower pace.
Prices are still going up!
If the base year data (where the index = 100) for a firm’s revenue is £200 000, what is the index number for revenue equalling £600 000?
300
What is the reason for cost push inflation ?
due to a rise in costs of production
What happens to the SRAS when cost push inflation occurs ?
causing the SRAS to shift up
Why do prices rise for consumers in cost push inflation ?
a rise in costs of production occurs, causing the SRAS to shift up, and reducing profit margins of firms. This then prompts firms to push up the final price of goods and services to maintain profit.
What are some causes of cost push inflation ?
National minimum wage increases.
Trade union wage increases.
Increase in world commodity prices, e.g. oil price rises globally.
External supply-side shocks, e.g. bad harvest abroad causing the price of wheat to rise.
Rise in indirect taxes, e.g. VAT (if it is passed on to consumers).
Rise in corporation tax (if it is passed on to consumers).
Falling productivity (which causes unit costs to then in that each good costs more to produce).
What happens when there’s a growth in the money supply ?
A growth of the money supply can also cause inflation.
This is because more money is pushed into the economy and therefore the purchasing power of the currency decreases. This leads to price rises.
What’s the impact of currency depreciation?
Exchange rate depreciation causes the price of imports to rise in domestic currency terms.
Note the exchange rate depreciation could happen because of events in another country that causes their exchange rate to appreciate, so causing the Pound to depreciate.
The Pound depreciated immediately after the EU referendum in June 2016, causing the price of imports to rise and inflation to increase.
What is the reason for demand pull inflation ?
When’s there’s an increases in aggregate demand outstripping aggregate supply. The economy is close to full employment, and increases in AD lead to the general price level rising because supply cannot keep up with increased demand.
What are some reasons for demand pull inflation ?
Exchange rate depreciation – causes the price of exports to be cheaper in foreign currency terms and thus demand for exports rises. This causes the value of exports to increase, so X-M increases.
Rising animal spirits (confidence) e.g. due to positive wealth effect from rising house prices.
Excessive borrowing.
Global economy experiencing faster growth in incomes and buying a lot of goods from the UK, causing UK exports and AD to rise quickly, causing demand-pull inflationary pressure.
Excessively ‘loose’ fiscal policy: income taxes could be cut too much or government spending be increased too quickly.
Excessively ‘loose’ monetary policy: interest rates could be cut too much or too quickly and Quantitative Easing could be too high.
What is the consequence of inflation on consumers ?
For individuals, inflation will erode the real value of money. That is to say, real incomes will fall, as the purchasing power of incomes falls. So standard of living also falls.
Inequality rises because the more skilled workers can negotiate nominal wage increases that keep pace or outstrip inflation.
Cash loses value more quickly. This means that some consumers take more trips to the bank (‘shoe leather’ costs).
Menu costs are the costs firms face of keeping prices updated in shops.
What are the consequences of inflation on savers and borrowers ?
Savers lose out because the real interest rate (nominal interest rate minus inflation) falls as inflation rises.
Borrowers gain because the real interest rate falls.
Indebtedness falls because the real value of debt falls as inflation erodes the real value of repayments.
What is the consequence of inflation on firms ?
Business uncertainty – volatile prices means firms may reduce investment because it is riskier.
Falling international competitiveness – a high inflation rate vs main trading partners will mean a country’s exports will be less internationally competitive.
What is the wage price spiral as a consequence of inflation .
As inflation rises, people start to expect higher inflation.
This leads to them asking for higher nominal wage rises to keep pace with the rising cost of goods in shops.
Firms may grant this to begin with, but then as their costs are also rising, they may have to pass this on to consumers with higher prices. So they demand higher wages again.
This can become a vicious spiral.
What is inflation expectations rose as a regular of inflation ?
this can cause people to spend now to avoid the future higher prices.
This could lead to demand rising, causing prices to rise even further.
Expectations of higher inflation could cause higher inflation: a self-fulfilling prophecy!
What do the consequences of inflation depend on ?
Is it unexpected or expected ?
Is it a temporary or persistent problem?
The extent to which workers have negotiation power in terms of unions or skill level.
What is happening to nominal interest rates via the central bank response?
What is happening to inflation rates in the rest of the world?
What is unemployment?
defined as the number of people who are actively seeking a job but currently without a job.
What are some consequences of unemployment for workers ?
Falling incomes.
Poverty.
Depression.
Health problems.
Poor standard of living.
Debt problems.
What is hysteresis ?
A rise in unemployment caused by a recession may cause the natural rate of unemployment to increase.
This is because when workers are unemployed for a time period, they become deskilled and demotivated and are less able to get new jobs - this is known as ‘hysteresis’.
What are the consequences of unemployment on the wider economy ?
Crime (negative externalities).
Higher fiscal deficit as tax revenues fall and welfare payments rise.
If there is hysteresis, the LRAS of the economy shifts in (its long run potential falls).
Loss of workers to foreign countries.
May cause rising income inequality.
If you are not seeking work what are you known as ?
Economically inactive
What are the two main measures of unemployment ?
Claimant Count
International Labour Organisation (ILO) measure
What is the claimant count ?
The Claimant Count (CC) is defined as a person who is receiving the Job Seekers’ Allowance
What is the ILO ?
The ILO measure defines unemployment as someone who has been actively seeking work for the past four weeks but ready and able to start in the next two weeks. This is collected in the UK by the Labour Force Survey.
What are the different types of unemployment?
Frictional unemployment
Structural unemployment
Cyclical unemployment
Seasonal unemployment
Real-wage unemployment
What is frictional unemployment ?
Frictional unemployment happens when people are between jobs.
Most economies will always have some level of frictional unemployment and it isn’t a huge concern for governments.
In fact, it can even be a positive sign for an economy because it may indicate that workers are willing to take risks by moving in search of better pay or a job they are better suited to.
What is structural unemployment ?
This happens when there is a mismatch between the skills that workers have and the skills that firms are looking for.
This is linked to changes in an economy over time and the changing demands of firms.
For example, de-industrialisation and the closure of the coal mines in the UK in the 1980s led to high levels of unemployment in the affected areas.
What is cyclical unemployment?
Cyclical unemployment is unemployment that is related to the business cycle. It is caused by the economy moving from expansion to recession, and is short term.
This is also known as Demand Deficient or Keynesian unemployment.
What’s seasonal unemployment?
Unemployment due to the seasons of the year (e.g. ski instructors in the summer).
What is real wage unemployment?
Real-wage unemployment is because real wages are too high in a market and they are above the ‘market-clearing’ (equilibrium) wage rate.
This is also known as Classical unemployment.
What are the reasons for real wage unemployment?
Free market economists might suggest that real-wage unemployment is caused by factors such as:
High trade union power.
High national minimum wages.
‘Sticky’ wages (slow to adjust).
If there was a higher rate of employment, what would occur ?
there would be economic growth:
Incomes would rise, people would consume more, the government could tax more.
However, people may also demand more imports and inflation may occur.
If the economic inactivity rate rose, what would happen to the economy ?
the government would be impacted:
Government expenditure (on benefits, pensions etc.) would rise
The government would receive less income.
If there was a higher rate of unemployment, what would happen in the economy ?
there would be slower economic growth.
Average income would be reduced, consumption would be reduced, the government would have to pay more benefits and receive less tax.
What are the two …-side factors that affect levels of employment and unemployment?
Both demand-side and supply-side factors
In the labour market what does supply side refer to ?
the supply of labour by workers
What are some supply-side factors that affect employment and unemployment?
Labour market flexibility, e.g. trade union strength
Skills of workers
Geographic mobility of workers
Occupational mobility of workers
In the labour market what does demand-side refer to ?
the demand for labour from firms
What are some demand-side factors affecting employment and unemployment ?
Health of firms, e.g. profit levels, demand for goods.
Confidence of firms.
Overall strength of economy.
Government intervention to encourage hiring.
Level of labour market regulation/costs of hiring.
If there’s a constant high level of unemployment in an economy what are the consequences ?
Fiscal issues
Living standard and inequality
Reduced output
Social issues
How are fiscal issues a consequence of high levels of unemployment?
‘Automatic stabilisers’, such as unemployment benefits, would increase government spending when unemployment is high.
The government would also receive less income tax and so would not have as much revenue to invest in public services to address the problems caused.
How is inequality and a fall in living standards a consequence of unemployment?
It is likely that those unemployed will suffer a dramatic fall in their standard of living.
High levels of unemployment may also increase inequality within an economy - those without a job ‘falling behind’ those who are earning and also potentially disadvantaging future generations who grow up in communities without work.
How is reduced output a consequence of high levels of unemployment?
If unemployment is not due to workers being replaced with capital, it is likely that real GDP will fall with increased unemployment.
Reduced confidence and multiplier effects could magnify the negative impact upon the economy.
How are social issues a consequence of unemployment?
High levels of unemployment can also be associated with increased rates of crime and other such activities.
These cost the government through expenditure on policing and also give rise to negative externalities.
What are the 3 main reasons for hysteresis ?
The insider-outsider effect
The long-term unemployed withdraw
Capacity scrapping
What is the insider-outsider effect ?
A fall in AD reduces output and employment as some people lose their jobs.
The insiders who keep their jobs have strong bargaining power inside their firms. Their firm-specific skills and bargaining power mean that they claim wage rises, rather than hiring more ‘outsiders’.
What is the long-term unemployed withdraw ?
People who are unemployed for a long time are likely to lose their skills, or they may become less motivated to do work in future
The unemployed outsiders become poor substitutes for workers in work. So the pool of available labour to do a given job falls
What is capacity scrapping ?
When AD falls and output falls, firms may close some factories or offices. They scrap some of their output capacity.
When AD recovers, firms reach high capacity utilisation earlier.
Which example is often cited as an example of the insider-outsider effect in action?
Spain after the eurozone crisis
Which of the following is the insider-outsider effect most likely to explain in an economy?
Very high levels of youth unemployment
What does the balance of payments show ?
a record of all transactions that a country does with the rest of the world
What is the balance of payments made up of ?
Current account
Capital account
Financial account
What is the current account made up of ?
Trade in goods and services (X-M).
Net primary income - net factor income from abroad (e.g. remittances, profits, interest on dividends).
Net secondary income - net unilateral transfers (e.g. foreign aid).
What is the capital account made up of ?
Sale/transfer of patents, copyrights, franchises, leases and other transferable contracts, and goodwill.
Transfers of ownership of fixed assets.
What is the financial account made up of ?
Net foreign ownership of domestic assets.
Hot money flows
What is the current account made up of ?
Unilateral transfers
Merchandise trade balance
Income receipts and payments
Services trade balance
What are unilateral transfers?
payments by governments or individuals in which money is sent abroad without any direct good or service being received.
The UK sending humanitarian aid to African countries, India or North Korea would count as a unilateral transfer.
What is merchandise trade balance ?
The merchandise trade balance is made up of the exports and imports of goods.
The sale of Aston Martins made in the UK would count as an export of goods in this section of the balance of payments.
What are income receipts and payments ?
Includes money received from foreign investments.
Investment income can come from investments abroad.
When someone invests in the US and makes a return, this is then transferred to the person in the UK who owns the asset.
What is the service and trade balance ?
This is made up of the exports and imports of services.
Barclays selling financial services (e.g investment bank consultancy fees) to a company based in Saudi Arabia would count as the export of services.
